“Investors should remember that excitement and expenses are their enemies. And if they insist on trying to time their participation in equities, they should try to be fearful when others are greedy and greedy when others are fearful.”
These are exciting times for investors, and that excitement is reflected in the price of stocks. The Dow is now trading above 12,000, having just reached its highest level since June 2008.
A lot of very smart investors and traders strongly believe that the uptrend will continue. Indeed, the Wall Street consensus expects 2011 will be another rewarding year for stocks.
But if, like Warren Buffett, you view excitement as an enemy and greed as a reason for fear, then the two and a half years of climbing prices should give you some pause. And if, like Buffett, you view expenses as an enemy, then you should have a fondness for both value stocks and ETFs of course.
One reason why the stock market has been on such a tear since 2008 is that interest rates are so low. Given the low valuations of stocks in 2008, the gap between earnings on stocks and returns on guaranteed investments was, and perhaps remains, quite high.
But Buffett acolytes and value-oriented investors would certainly feel more comfortable buying bargains, which give investors greater downside protection when the next correction occurs.
There are many ways to measure value; doubtless, Warren Buffett has more sophisticated ways at his disposal. For our purposes, I am using P/E ratios as a generally accepted (very loose) measure of value. (Note that different ETF providers may calculate the fund’s average P/E differently.)
If you were expecting sleepy utilities funds and or perhaps the Egypt ETF (EGPT) (or those of other unstable foreign lands where crashing prices would be expected to improve the P/E), you’d be in for a surprise. Indeed, the results are even a little big exciting, which Buffett cautions investors against.
In data provided by Morningstar, the four leading ETFs of five with the lowest P/E ratios are in “hot” areas. Top of the list, with a P/E of 2.41, is the First Trust U.S. IPO Index (FPX). PowerShares Lux Nanotech’s (PXN) P/E is just 7.45. Guggenheim China Real Estate’s (TAO) P/E is 7.70 — has the bubble finally popped?
The iPath MSCI India Index ETN (INP) weighs in at 7.93. No. 5 is the iShares FTSE NAREIT Mortgage Plus Capped Index (REM) with a P/E of 8.74. I could almost see Buffett in that one.
For help on in resolving this investing conundrum, we turned to Morningstar ETF Analyst Michael Rawson, whose immediate reaction was “maybe there’s something wrong.” Indeed, looking under the hood of the IPO ETF, Rawson — the next Warren Buffett, you heard it here first folks — immediately noted: “The largest holding in the IPO fund is GM — I wonder if they even have a P/E ratio.” And indeed GM’s P/E is less than 1. “It’s not a valid P/E; it’s skewing the whole portfolio,” Rawson pointed out.
Mr. Buffett, if you’re reading this, don’t despair yet. “If you look at the underlying holdings, a lot of them are the ones he’d be expected to like,” says Rawson, pointing to Lorillard (LO) and Tyco (TEL). “But he’d look at the underlying P/Es of the different businesses rather than just look at the fund.”
Should low P/E ETFs interest investors?“I think there is validity to using valuation ratios for ETFs,” says Rawson. You just want to make sure that “the data is clean” for the underlying holdings, which takes a bit of work sorting out.
But that’s what you have a Warren Buffett — and Michael Rawson — for.